These funds buy low and sell high

Balanced offerings trade when investors might not

Conradde Aenlle

LONG BEACH, Calif. (MarketWatch) — One of the few ways to get what amounts to free money in the markets is to rebalance your portfolio.

Say you prefer to keep 60% in stocks and the rest in bonds. If stocks outperform so that they account for 70% of your assets, you could restore the desired balance by selling stocks and buying bonds.

Rebalancers have a distinct advantage over buy-and-holders, as Jason Hsu, chief investment officer of Research Affiliates, a firm that specializes in asset allocation strategies, points out in a report to his firm’s clients.

By implementing a system in which they dispose of assets that have risen in price and accumulate what has become cheaper, he noted, investors are forced to buy low and sell high.

There’s just one problem with rebalancing that Hsu’s report highlights: Investors often fail to do it. He cites studies confirming that stocks and corporate bonds that have fallen in price have better future returns — buying low and selling high works — but he observes that investors nevertheless tend not to increase their exposure to cheaper assets. The declines in the value of their portfolios push them to become more cautious, he explains, just when it’s time to throw caution to the wind.

“Investors tend to become more risk averse and, therefore, unwilling to add risk to their portfolios despite lower prices when their portfolio wealth declines. Investors tend to become more risk seeking and, therefore, more willing to speculate even at high prices when their portfolio wealth increases.”

Balancing act

When it comes to rebalancing — doing it, not just thinking about it — fund investors have an edge over owners of individual securities.

Funds are easier and cheaper to trade than single stocks and bonds.

More important, while rebalancing is optional for you, managers of many funds whose primary purpose is to stay balanced between stocks and bonds are required to rebalance, although Todd Rosenbluth, a mutual fund analyst at S&P Capital IQ, points out that they typically have some leeway in setting the proportions.

“If you’re calling yourself a balanced fund, you need to stay within certain guidelines, but the guidelines are wide,” he said in an interview. “You tend to see funds where they give management flexibility depending on the market environment.”

A typical portfolio will keep 60% in stocks and 40% in bonds, he said, but if the managers expect big things from stocks, they might be permitted to go as high as 65%. “They want investors to have an understanding of where they want to go,” Rosenbluth said, “but they also want them to understand that they can be flexible too.”

Rosenbluth identified five balanced funds that can help investors by doing their rebalancing for them and ensuring that they stay disciplined. All five have five-star ratings under the S&P Capital IQ system: American Century Balanced
TWBIX, +0.05%
; T. Rowe Price Balanced
RPBAX, -0.04%
; Mairs & Power Balanced
MAPOX, +0.17%
; American Funds American Balanced
ABALX, -0.11%
and Vanguard Balanced Index
VBINX, +0.11%

The last one may be the best choice. Like all index funds in the Vanguard family, Vanguard Balanced provides excellent value for the money.

Total annual expenses are a reed-thin 0.24%, for a portfolio designed to match a broad index of American stocks with 60% of its assets and a similarly broad bond index with the remainder.

“We like that fund,” Rosenbluth said. “You’re going to get exposure to large-capitalization stocks and a diversified fixed-income portfolio, and it’s going to cost 24 basis points.” That’s substantially cheaper than the average actively managed balanced fund, he noted — one reason that it has outperformed its peers over one, three, five and 10 years.

American Funds American Balanced, by contrast, doesn’t seem like much of a bargain. Its annual expenses are a reasonable 0.62%, but the fund has a 5.75% sales charge that should produce a serious case of sticker shock in anyone considering a purchase. It’s nice to get free money, but you don’t want to pay too much for it.

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